UK share prices brush aside Brexit concerns

Tuesday 30th August 2016

Written by Martin Upton

The unexpected vote to leave the European Union in the June referendum sent shock waves through the financial markets with share prices and the value of Sterling plummeting in the aftermath of the result.

In subsequent weeks Sterling has continued to weaken as survey evidence suggests that the economy is slowing in the wake of the vote and as real fears of another recession in the UK take hold in the currency markets.

On 12th August the Pound had dropped in value by 13% against the US Dollar and 11% against the Euro since referendum day on 23rd June.

But the real surprise story has been the way that UK share prices have rallied both quickly and strongly since the initial reaction in the equity markets.

On 12th August the FTSE-100 index closed at 6916 – its highest level for 14 months and some 19% higher than its lowest point during the day after the referendum vote.

The scale of this turnaround has also been matched by the FTSE-250 index.

So why have UK share prices seemingly been defying economic gravity?

There are many hypotheses – but let’s look at four reasons for this share price rally.

First, the fall in the value of the Pound makes UK exports more price competitive. Good news for those companies who are particularly active in overseas markets.

Second, many of the companies that comprise the FTSE-100 conduct a major proportion of their business overseas even though their shares are listed in the UK. The financial health of these companies is, therefore, not overly reliant on the strength of the UK economy.

Third, the increasing likelihood is that the UK will not leave the European Union until 2019. So, arguably, its ‘business as usual’ for the UK for around another three years.

Sentiment in the financial markets often heavily discounts the outlook for the economy beyond the short- and medium term, focussing instead on the near term prospects.

So the share markets may be taking comfort from the short-term outlook for businesses rather than guessing how the eventual terms for Brexit impact on company earnings.

Whilst all these factors may be influential my personal belief is that there is a fourth key factor pushing up share prices – the search for yield on investments.

The weeks since the referendum have seen Bank Rate cut to a new historic low of 0.25%, taking interest rates on savings accounts down with it.

We have also seen returns on bonds falling further, with the annual yield on 10-year UK government gilts now a miserly 0.61%.

For those thinking of investing in property there is the fear that with the Brexit uncertainties house prices may at least stall for a time after their strong upward trend since 2012.

Faced with these realities for other investments investors are being drawn to equities in the search for higher returns. Indeed those who invested in FTSE index funds within a few days of the referendum vote have already seen impressive double-digit returns in less than two months. Not bad at all for a period of both economic and political uncertainty!

*Martin Upton is Director of the True Potential Centre for the Public Understanding of Finance (True Potential PUFin)